Why Facebook Stock Has Limited Upside Potential

Last week, eMarketer released its digital advertising spend report. The report revealed Facebook (FB) had overtaken both Microsoft (MSFT) and Yahoo (YHOO) to second-largest digital ad seller in the US, behind only Google (GOOG). At first glance, this looks positive for the social media giant, but does it offer an inaccurate reflection of the company’s outlook?

The Numbers

Digital advertising revenues in the US will total $42.58B during 2013, up from $36.80B during 2012. Facebook will take in 7.4% of that total, or $3.17B. Microsoft’s share of US digital advertising revenues will fall from 6.2% last year to 5.9% this year. eMarketer expects Yahoo’s share of US digital advertising revenues to decline to 5.8% in 2013, from 6.8% last year.

The global figures reflect those of the US, with the exception that Yahoo and Microsoft have switched rankings. Worldwide digital advertising revenues will total $119.52B, up from $104.22B during 2012. Facebook will take 5.64% of those revenues, or $6.74B. Yahoo will take 2.87%, or $3.43B, and Microsoft will take 2.85%, or $3.40B.

Google

All this initially seems like good news for the company’s shareholders, but when these statistics are considered alongside those of Google, this is not necessarily the case. Last year, Google dominated the online advertising industry, attracting 40.9% of US digital advertising revenues. While eMarketer suggests a small decline in this dominance during 2013, the research organization still estimates Google’s share of revenues to be 39.9% of total, rising to 42.3% by 2015. In contrast, the report suggests that while Facebook’s share of revenues could nearly double by 2015, to 9.0%, Google will still take $4 out of every $10 that marketers spend on digital advertising.

Why Facebook’s Growth Potential is Limited

The major flaw in Facebook’s growth strategy is rooted in the company’s potential for expansion. It is reasonable to suggest that Facebook has reached a point where it is limited in its ability to attract more users. The vast majority of Facebook’s dominant demographic, those of ages 16-50, either already uses Facebook or never will. This means that any increase in revenues for the company must derive from an increase in the amount of advertisements displayed on the social media site. A typical Facebook page already contains banner advertisements, news feed native display advertisements and now news feed video advertisements. Having nearly reached a point of market saturation, the company has now nearly reached a point of display saturation. In short, there is no more space on a Facebook page to advertise. The untapped potential of businesses that do not yet advertise on Facebook becomes irrelevant when there is nowhere to place their advertisements.

Facebook is Nothing New

The previous section brings us to another difference between the two companies. When Google started placing sponsored search results on its results page, the company revolutionized the online advertising industry. For the first time marketers were able to advertise relevant goods and services in real time to a user. Not only this, the advertisements are complimentary, in that they can be just as pertinent as the non-sponsored results. Facebook advertisements however, are no different to the display advertisements that have been around since the internet’s inception. While increasingly sophisticated data manipulation has made it possible to increase the relevance of display advertisements to a user, their presence is still seen as invasive as it lacks the real time element of a Google search. In short, Facebook imposes advertisements upon a user, whereas Google offers them up on request.

Does the Company Recognize its Limitations?

In a recent CNN article, a journalist reported that recent actions by both Facebook and its Founder and CEO Mark Zuckerberg suggest that both parties recognize the company’s limited potential for expansion. Zuckerberg is reportedly set to sell 41.4M shares of his Facebook stock holding, valued at approximately $2.3B, to cover the cost of a tax bill. Alongside Zuckerberg’s sale, Facebook is selling a further 27M shares to “cover working capital and other general corporate purposes.” These shares will be dilutive to existing Facebook shareholders. The question arises as to why the company is diluting its shareholders when there are other, non-dilutive, methods of meeting operational expense, namely, low interest debt financing. The answer to the question being Facebook must perceive its stock as overvalued.

What is Next?

In order for its stock to warrant further upside, Facebook must diversify its revenue streams. Advertising, in the traditional display sense of the word, cannot offer the company any substantive expansion potential. One suggestion, touted throughout 2012 as a viable solution is commerce. During that year, Facebook released credits with which users could buy and sell items within games, and reportedly looked into developing these credits into a digital currency that users could use to buy and sell real world items across the Facebook platform. The company has since dropped this idea, which now looks to have been a mistake. The meteoric rise of Bitcoin, championed ironically by the Winklevoss twins, started around the same time as Facebook abandoned its credits. Since then, Baidu (BIDU), Tesla (TSLA), Reddit and WordPress have all accepted the digital currency as payment. Public perception of Bitcoin is improving, with some IRAs now offering Bitcoin investment and exchanges like BTXtrader, recently acquired by WPCS International, making digital currency safer and more accessible. With its vast reach, Facebook could a) implement its credit system once more, and take a commission on dollar to credit exchange, or b) adopt Bitcoin and develop a commerce platform through which users can purchase the goods and services the platform already advertises.

Data

Another opportunity is rooted in the vast amount of data Facebook holds. The company stores more than 300 petabytes of information on its servers, which has a huge number of potential applications from politics to healthcare. This range of applications makes the data extremely valuable, yet at present Facebook only uses it commercially to leverage the attractiveness of its advertising offerings to advertisers.

Final Word

If Facebook stock is to continue increasing in value, the company must find alternative revenue streams. This could be through commerce, or through leveraging the data it has collected, but one thing can be said for certain—display advertising, be it native or banner, is not going to take market share from Google.

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